Inflation

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  •  It refers to the persistent rise in the general price level, i.e., in the price of goods and services.
  • It reduces the purchasing power of money and ultimately hurt the economy in many ways.
  • There is a loss in real value of money as medium of exchange and unit account in the economy.
  • Ex: Before Inflation 10 tea for Rs. 100 but because of inflation 7 tea for Rs. 100. (Inflation value keep 2% - 6%).
Why Inflation Occurs
1.Increase in Money Supply
  • The most important reason of inflation is excessive growth of the money supply.
  • A long sustained period of inflation is caused by money supply growing faster than the rate of economic growth.
  • When there is more money in the system, too much money chases too few goods.
2.Increased Effective Demand
  • Another important reason for inflation is increased effective demand for goods and services. When there is an increased demand, the people tend to offer higher price for same good or commodity.
3.Decreased Effective Supply or aggregate output
  • Negative changes in available supplies such as during scarcities cause inflation.
Classification of Inflation
Though causes of inflation are multi-dimensional but broadly it could be expressed in two forms:
  • Demand-Pull-Inflation. (Demand ↑↑ - Supply Constant)
  • Cost-Push-Inflation. (Demand Constant – Supply ↓↓).
It means that inflation is caused either due to increase in demand, because when demand will be high prices, will certainly go up and increase in the cost of production, or due to both.
Demand Pull Inflation
  • Demand Pull Inflation occurs due to increase in aggregate demand in economy, mainly due to increase in money supply
  • It occurs when demand far exceeds the supply.
  • Ex: COVID time – Demand of Mask & Sanitizer.
Factors leading to Demand Pull Inflation
  1. Increase in Money Supply in economy
  2. Increase in the Population (Leads to increase in demand for goods and services)
  3. Increase in government expenditure (Deficit financing or high fiscal deficit)
  4. High inflow of Foreign Exchange in the economy, leads to high liquidity in domestic currency
  5. Prevalence of black economy
Cost-Push Inflation
  • It is also called as Supply Shock inflation; it is caused due to reduced aggregate supply with constant demand or increase in cost of products
Factors leading to Cost Push Inflation
  1. Rise in cost of Factors of production like land, labour and capital When production costs go up, there is an increase in prices to maintain profit margins. Increased costs can include things such as rise in rent, wages and interest respectively.
  2. Infrastructural bottlenecks leading to fall in supply this type of inflation is also called as Structural Inflation.
  3. Increase in Indirect taxes like GST adds up to the cost of commodity
  4. Black marketing, speculation and hoarding causes the supply shock and inflation
  5. Rise in cost of fuel and petroleum products
  6. Other seasonal factors like erratic monsoon, weather conditions etc.

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